By Mark Murray
Life sciences companies in their early stages are in constant need of capital to continue along their path to meeting clinical milestones. Most are pre-revenue and focused on successful completion of Phase I and II clinical trials. And with strong clinical data, these investment prospects are attractive to sources of capital, both private investors as well as potential strategic acquisition partners.
In my experience, I’ve seen life sciences companies simultaneously receiving term sheets from both financial investors and strategics. And I’ve seen other companies, while in the midst of raising capital from financial investors, get approached from potential acquirers. Naturally, there are pros and cons of choosing each of these paths to funding clinical development and building commercial capabilities at a company. Private capital allows a management team to stay in control of their destiny to continue to invest according to their own priorities in research, clinical trials and product development. Acquisition, on the other hand, can open up key marketing and distribution pathways and capabilities and a richer immediate payout, depending of course on the company’s agreed-upon valuation.
So how does a life sciences CEO make the tough call around “sell now or sell later”?
I would point to four key factors when making this key strategic decision:
#1: The company’s valuation today vs in the future
A company’s acquisition price will of course be governed by market conditions, competition and size of the market opportunity. But if a company team believes its valuation path (future valuation) is a strong one, acquisition may seem premature. If a company foregoes acquisition, however, it will also require additional infusions of private investment capital to increase its valuation (and of course balance concomitant dilution effects for its current investors). There are risks here both in terms of finding willing investors and successfully meeting product milestones. Typically, we see companies requiring a future (2-3-years out) valuation of at least 30-40 percent above today’s value to justify passing up acquisition today, in favor of acquisition further downstream.
#2: Proposed M&A structure
A second consideration impacting “sell now vs sell later” in life sciences companies should be what the potential acquirer is proposing around the amount of the “upfront” payment and milestone payment. This can be especially important if your product has already achieved easier clinical milestones and regulatory requirements but faces higher-risks of meeting later-stage milestones. How proposed payments line up with the timing of and risk profiles for upcoming product milestones needs to be carefully reviewed since there is always the risk that an acquirer may be less willing to do the heavy lifting downstream to support necessary requirements for investment. Particularly at larger life science companies, distraction from and competition with other portfolio assets they own can pose risks to your company remaining in the capital “limelight”. As CEO, you and your board need to ask yourselves the critical question “what if we end up with ONLY the upfront payment?”. Would this deal still be a good one from the point of view of current investors?
Your evaluation of a proposed M&A structure should also carefully review the acquirer’s contractual requirements for drug or device development, marketing and commercialization. How much are they committing to? What value-added benefits will these bring in terms of the acquirer’s scale (e.g. enterprise sales teams, distribution leverage, marketing budgets etc.) vs the “go it alone” (build infrastructure/outsource) scenarios inherent in remaining independent?
#3: Strength of your current investor syndicate
A third consideration is who your current investors are and how much you can rely on them to be willing and able long-term partners as an independent player. What are their investment interests and horizons? What are their capabilities financially in continuing to fuel new rounds? Is your vison of your product and company’s future in sync with their views? If not, will you need to bring in new investors?
#4: Outlook around business risk
Finally, all life science CEOs must be clear headed about the true business risks associated with their product markets. These risks fall into at five areas; clinical, reimbursement, IP, competitive and operational. Remaining independent requires that your company be built to manage and mitigate these risks, or you will ultimately fail, regardless of the promise your product offers to investors and end-user markets.
Clinical and regulatory risk
The prevailing benchmark is that less than 10% of life science companies in the Phase I stages reach commercial markets. And then, beyond clinical trial hurdles, the FDA must approve your product. Simply put, a lot can go wrong along the way to commercial success in drugs and devices.
Once you have met clinical and regulatory hurdles, getting your product reimbursed by public and private insurers and negotiating a fair price with benefits middlemen is your next one. Unfortunately, the outlook here is getting progressively worse due to public policy towards healthcare economics and related concerns over drug company price inflation.
Intellectual property risk
As with all innovations, the need to protect your proprietary drug formulas and medical devices is paramount. Depending on your category and your competition, this can be a moderate or a significant risk, short term and longer term.
Market and competitive risks
Beyond the development stage, you must fairly judge your ability to successfully commercialize your product when you are competing with large life science companies capabilities on the sales and marketing front. Their ability to bundle drugs and devices and offer price competitive packages to distribution partners and use advertising dollars to out maneuver you should not be minimized. And any distribution agreements with partners that your company uses to counter these players need to be carefully reviewed and negotiated for optimal value at the right cost.
Similar to distribution requirements, operational requirements for drug and device manufacturing are significant. Investments need to be made in quality control systems, enterprise networks and systems to manage compliance with regulatory rules and guidelines. . Outsourcing manufacturing might mitigate this to some degree but again, effective partner negotiations around cost are critical to ensuring maximum profitability.
These decisions around “sell now vs sell later” are a critical strategic turning point in a life sciences company’s future. Careful analysis and evaluation of the ROI for investors need to balance current vs projected risks and returns like any other potential investment. If you are managing an emerging company in life sciences, weighing the four considerations above will help you and your board make better decisions around this important pivot point in your company’s trajectory.